Transcript of Question & Answer Session Innovation and Dynamism in the Post-pandemic World

Thanks so much, Luci. There's a lot to unpack there. Before we kick off the discussion, just a reminder to put forward your questions on the Pigeonhole app, by going to ceda.pigenhole.at, and using the passcode, RBAUPDATE, one word all caps. And we'll hand over to answer as many questions as possible during the allotted time. So if there's a question you particularly like, make sure you vote for that as well to move it up to the top of the line.

To kick things off, I just wanted to pick up on a few of the points that you made. Firstly, you mentioned the lack of dynamism not being unique to Australia, and that we're seeing similar trends in a number of countries. I'm just wondering if you could unpack that a bit more and in particular, whether you have any views on the impact of the low interest rate environment on innovation and risk taking. So on the one hand, it seems obvious that low interest rates make it cheaper for businesses to borrow, and that should be a good thing for investment. But I wonder on the other hand, if it's contributing to excessive focus by shareholders to chase short term returns and put pressure on businesses to generate short term returns. And whether that sometimes comes at the expense of longer term innovation and investment that takes time to come to fruition and be realised.

Thanks, Melissa. It's a very good question. As I mentioned in my talk, this reduction in dynamism isn't Australia specific, it seems to be evident in other global economies. And in thinking about the role of low interest rates, in many respects, low interest rates are a consequence of the lack of investment. The saving and investment balance is such that people are craving safety, so they're saving, but they're not taking opportunities, so there's less investment. And so the thing you need to do to get those two things to equalise, which is what happens in many economies, is that the rate of interest needs to fall. And so that's for the technical among us, it's the decline in R-star, the real interest rate you need to get balanced growth in the economy appears to have fallen. And I would say that the interest rate regime is a consequence of that. And then coming back to what I said in my talk, hurdle rates haven't fallen. So that's really telling me that, despite the fact that the cost of capital has come down, the return that businesses are demanding is remaining high.

That's a really good a point. You spoke quite a bit about incumbency and I'm interested in that point as well. And wondering if, in some ways, are we victims of our own success? At the micro level with the individual superstar firms, they can obviously be well rewarded as you pointed out. But we also know that successful firms can develop inertia, and that can make it hard for them to see and respond to future opportunities and threats. And then if you look at the macro level, we've had almost three decades until recently of uninterrupted growth. Do you think that's bred some complacency?

Well, Australia has seen three decades of almost uninterrupted growth, but that hasn't been the case in some other countries. So again, this is a global trend and so we shouldn't look to Australian specific causes. But absolutely, I think there is a sense in which we are seeing increased concentration across a range of industries. It's not obvious that these are necessarily superstar firms, it is really just a story of incumbency. There's also a huge literature, which I didn't get into in this speech around the rising profit share, which is another way of saying that margins are increasing. So there is a question about whether that's a benign development. If an increase in profit share and incumbent companies that were very profitable was engendering more investment, more innovation and more productivity growth, it would be something you could be a bit more comfortable about, but the configuration that Australia and other countries have just doesn't seem to be as benign. So I think that's part of the story.

And on the pandemic, the crisis experience, as you said, businesses have adopted innovations in the space of weeks or months that would usually take years. What do you think we need to do to sort of harness this momentum outside of crisis periods? And I'm curious to know, I know the RBA has an extensive liaison program with businesses, whether the liaison program offers any insights into where businesses minds are at on this front. Earlier in the pandemic, we heard a lot of the mantra of we're going to build back better. Are you hearing that businesses are keen to continue this, or do they feel they've done enough for now? Or are they adopting a wait and see approach given the uncertainties that they're facing?

Well, I don't think there's one sort of consistent message across all our liaison contacts, but the idea that we need to build back better is often used as an argument about something government should do. And as I pointed out in my talk, we can't point to changes in regulation in one country to explain this. This is a global phenomenon, so it seems to me that it does actually come down to self-belief and let's try and work out what it was that enabled us to make those changes during a crisis and can we ensure that we can make those kinds of changes without the same level of inertia?

I think honestly, it is about risk during crisis times you're willing to say: ‘Well, if this doesn't work perfectly, it's okay because it's better than the alternative.’ Whereas when times are a little bit more benign, they'll say: ‘No, we want to take the time to get it right’. Some of it has to be about the incentives that people face. As I mentioned in my talk, nobody wants to be associated with a failed project. And so I think that does create a certain level of inertia. People are much more likely to be sacked for being associated with a failed project than they are for not taking an opportunity that nobody else took either.

Yeah. There's some interesting research on the risk aversion front, looking at the differences between risk appetites at different levels within organisations. And that the CEOs take a portfolio view, but the individual managers beneath them can be really risk averse and feel like they're betting their career on each decision and they're not willing to put forward that that risky, bold, neck-on-the-line idea. So that is … yeah risk aversion is something that has come up a lot when we've been discussing business dynamism and innovation with CEDA members. Just looking at the questions that are coming in thick and fast from the audience, and the one that's received the most votes so far is people are really keen to hear your views, Luci, on whether there are regulatory barriers to business dynamism in Australia.

Well, Melissa, thanks. Yes, I saw that one getting all the votes too. And I think this really speaks to the point I was making in my speech. Instead of looking to whether or not businesses are taking opportunities, and the incentives that individuals within organisations are facing, there is a tendency to say: ‘Oh, well it must be something the government's doing or not doing’. And that the fixes come from government." And as I said, in my speech, this is a global phenomenon. We can't look at particular countries' regulation and say, ‘well, that's the story’, because it's common to all sorts of different countries with different regulatory setups.

Absolutely. And what do you see as the role of the RBA in encouraging dynamism and risk taking?

Well, for those of you who've read the text, it does feel a little bit rich for someone who's spent 30 years at the central bank to be telling people to take a risk and be innovative – I do have an Innovator's Award, but that's a bit of a long story. I think all we can really do is provide a stable economy, a deal of certainty. Be clear about what we are planning to do, and the decision-making framework that the Board uses to make its decisions. And, I think, maybe a few speeches here and there. That really is all we can do.

At the end of the day, interest rates are a blunt instrument, right. There's a few questions in here on leadership capabilities and management capabilities, which I'm very excited to see because that's an area that CEDA's been thinking a lot about. We've been looking at the research at management capabilities and that they really, really matter. One study, for example, has shown that half of the productivity gap between Australia and the US can be accounted for by differences in management capabilities. And in particular at CEDA, we're focusing our attention on dynamic capabilities and that businesses need to thrive in an uncertain environment.

So I'm going to give a shameless plug for the survey that we're currently undertaking to assess the dynamic capabilities of Australian businesses. I encourage all the businesses leaders listening to the call today to get in touch and participate in this research.

So what do you think about the role of leadership capabilities and the role of government in encouraging those capabilities of Australian firms? Some of the questions coming in are to that effect.

Well, again, I mean we keep saying, what can government do to make businesses do what surely businesses have the financial incentive to do? I mean, if it is indeed the case – and I admit Melissa, I'm not familiar with this literature –= but if it is indeed the case that Australian businesses lack management capability that American businesses have, why aren't we sending people to learn from them? Why are businesses leaving that on the table? There's a question … there's an unbridged gap there that I really just struggle to understand. Why would businesses leave that money on the table by not investing in management capability?

Yeah, I think that's a good point. Two points on that, that I've seen in the literature. One is that you're absolutely right, that international diffusion of ideas and exposure to international ideas, whether that's true. Being part of multinational corporations or experience overseas or exposure to export markets do seem to have a correlation with higher management capabilities. So there's definitely a role for that international exposure. The other really interesting – I found it really interesting – part of that literature is that there's not really a correlation between what managers think that their capabilities are at and their independently assessed capabilities. So there seems to be a bit of a blind spot there for businesses.

So that's something for businesses to consider is working out, first of all where they're up to, and identifying ways in which they can improve because it does make a difference.

Another question coming through that's received a lot of votes, Luci, is could rising levels of household indebtedness be contributing to the reduced willingness of workers to move between jobs? You showed that really stark graph with the job mobility decline since the 70s. Has household indebtedness got anything to do with that?

Thanks, Melissa. It's an important point. I can understand a world in which people facing the need to make their mortgage repayments might be a bit reluctant to do something particularly risk-taking, like start their own business. But I would've thought that if you have a big mortgage, you'd be more willing to take a new job that offers higher pay.

So I think what this is telling you is that there are two things that make people leave their jobs. I mean there are socioeconomic reasons like their family are moving or they're looking for more career progression, but primarily there are two reasons why people leave a job. One is because they hate their boss. And the other is because they got an offer that was significantly better pay and more career opportunities than the job they left. They might have been happy in the job they left, but they were able to get a better job. And so it seems to me that the missing link here is firm's willingness to actually increase wages. And particularly in Australia, but also globally, we saw what in the profession we would call a very flat Phillips Curve. It really took a lot to start seeing a tight enough labour market before firms started increasing wage offers. And so it's that willingness to increase wage offers that may well be the issue, or at least part of it.

On the topic of the labour market, there's a question here about whether you think skills shortages are holding back businesses that want to be innovative and risk-taking?

Well, a skill shortage is simply that nobody wants the job at the wage that you are offering and there is a really simple solution to that. And similarly, I think what tends to happen as labour markets tighten, is that firms start being a bit less precise in their requirements and show a willingness to hire someone who may need some training, rather than expecting someone who is fully cooked. And saying, oh well I only want someone with two years' experience now rather than five years. And it's quite common, I mean you go onto some of these job sites and there'll be quite a lot of discussion and opinion columns saying, well, all these firms, they say it's an entry level position, but they want six years of experience and a PhD and whatever. And so what happens is over time the mismatch between firms' expectations and what the market is requiring to induce someone to change jobs finally comes closer into line.

One more on the labour market before we move on. There's been a lot of votes on a question. This one's from Catherine Domanski, about whether you can comment on the likelihood of a great resignation. I presume she means the likelihood in Australia. We've obviously heard a lot about this topic coming from overseas. How applicable do you think it is here?

Thank you, Catherine, for asking this question because it does give me the opportunity to address it. Through last year, we saw a greatly reduced rate of people leaving their job voluntarily to switch jobs because, again, during times of uncertainty they hang on. I fully expect there will be a little bit of catch up through the second half of this year and into next year as people who might otherwise have left their jobs back then are doing it now. So there'll be a little bit of catch up. But I don't think we're in the same situation as the United States. And to be honest, this is really mostly a United States story, where a lot of what is going on is that frontline workers, people who are relatively lowly paid, have experienced being locked down and they didn't even get furloughed. They didn't have JobKeeper, they were put on unemployment benefits. So firstly, you've got to stitch everything back together.

But I think the very different experience that many lower paid Americans experienced relative to here in Australia in terms of the support they received and the way we handled the health situation, I think that's just going to be a very different experience. The wage rates at the lower end in the US are very low and I think a lot of people saying: ‘why am I doing this for this rate of pay?’ And that shock leads them to expect something, to look for something a bit better rather than staying put. Whereas in Australia, because of JobKeeper there wasn't that immediate shakeout. And so you don't have that experience of people being, sort of, forced to reconsider their status quo in the same way that Americans who were more likely to be laid off rather than kept on in the same circumstances because they didn't have JobKeeper.

Moving on from the labour market. One question here is a broader one about whether there are particular industries or sectors that have been particularly affected by a lack of dynamism. Do you have any insights on the breakdown there?

My understanding of the literature is that it is pretty broad based. There's no one industry that you can really sort of highlight as being most affected by this.

One industry that's obviously received a lot of attention over the COVID period has been the higher education industry. And there's a question here asking whether higher education has a role to play in encouraging knowledge, diffusion, innovation and adaptation. It's something that's on the federal government's mind. They've got the university research commercialisation task force underway. Universities are potentially more open to these ideas. What are your views on the higher education sector?

I think the higher education sector has a big and important role to play in encouraging innovation and dynamism. And in fact, if you look at the patents that come out of Australia, some combination of the CSIRO and universities are very highly ranked relative to the sort of non-mining, non-gambling corporate sector.

One of the interesting statistics seems to be that we're very good at coming up with new ideas, but not so good at translating those new ideas and new knowledge into new products and outputs. That's a challenge in Australia, at least in terms of our journey on the dynamism and innovation front compared to some of the other OECD countries.

On this topic of knowledge diffusion, there's a question here from Angelina Bruno. She said Treasury – and she's referenced Megan Quinn in 2019 – identified widening productivity dispersion. The question has moved. I might come.. there it is. Apologies. Treasury identified widening productivity dispersion amongst firms as an indicator of slowing knowledge diffusion and should innovation policy focus more on diffusion rather than creation?

Well, it's well outside the remit of a central bank to say what innovation policy should look like. But I think what the work that Megan is citing and among some of which comes out of Treasury and which I've cited, what that research is saying is that you do need to pay attention to both. It's about diffusion and creation.

Absolutely. Coming back to some of the comments you made about risk tolerance and opportunity I found really interesting. And one thing I've been thinking about there is the distinction between risk and risk tolerance versus uncertainty. So whether it's that firms have become more risk averse, or they're just finding it harder to make those cost-benefit assessments in the usual manner because there's a large degree of uncertainty and it's hard to put probabilities on potential outcomes. CEDA members have definitely been telling us that the outlook is more uncertain and rapidly changing, and you can point to numerous examples of that in terms of the digital transformation that you touched on and also the climate revolution. Do you have any thoughts on this risk versus uncertainty distinction?

I think it's an important thing to highlight that uncertainty is actually what we are talking about in many respects. I mean, they are two different concepts, risk being one where you're assigning probabilities to things and uncertainty where you're really just not sure. But you know, businesses understand about decision making under uncertainty. They understand that markets can shift. If you look at any of the business literature, nothing comes down to a regression or a probability statement. It's ‘well, what could happen to this industry?’ ‘How do you know, when you should be paying attention to the possibility of a changing trend?’ So, I think it's an important distinction conceptually, but it may not be as important in practise.

And I think that's where some of these dynamic capabilities that we've been thinking about really come in, that's very much focused on operating in an uncertain world. So we're interested to see whether firms in Australia have those capabilities to sense and seize opportunities in an uncertain environment and really harness some of those opportunities that are coming their way. So it will be interesting to our findings on that front.

On the topic of risk aversion, there's a question here from Sophia Rodrigues. She's asking if the post-pandemic world is unlikely to be a risk averse one, as you suggest, what impact would this have on growth? And have you factored this possibility into your forecasts or in your upside scenarios?

I think the way I would respond to that is to make it clear that although we publish scenarios that are specific to particular configurations of how things could turn out differently, we also have an extensive segment in our Statement on Monetary Policy where we talk about other risks and uncertainties. And of course these are the kinds of issues that we're grappling with when we put our forecast together. But oftentimes these are things that are more a three- to five-year to 10-year issue more so than the next year or two, which is what our published forecasts really cover.

I don't think you'd really expect to get out of this without a housing question, Luci. There's a lot of votes here for this question. An anonymous question, linking housing back to investment more broadly. The question is, has the propensity for housing investment in Australia reduced the appetite for investment in productive capital?

Yes, you're right, I couldn't get away without one. And so the first point I'd make in response to that is, again, these are global trends we're talking about. And so it's hard to ascribe what we are seeing and what I described in my speech as having anything particularly Australian-specific. There may be some Australian-specific factors at work.

One thing I should point out is of course, why do we actually build homes? It's to house our population. And because Australia has until very recently had much stronger population growth than other countries, you kind of have to keep building more incremental housing relative to the size of your housing stock with high population growth, than if you have low or no population growth. So in many respects, that's just an artefact of the growth in population.

I think one other thing that people haven't really sort of taken account of more recently is if we are talking about work from home and increased hybrid work modes, that means the home you live in is now also a workplace. And for all the sort of discussion of housing being an unproductive asset, it isn't now, it's a workplace. And so I think that line becomes a lot more blurred now. And particularly in terms of people focusing on having a larger home with the home office, demand for renovation, I think you'll see that aspect become part of the story, but a lot of that may well be the changing nature of the home as a place of work.

I think that's a really good point. You mentioned there, and it's a theme that's come through this discussion, that this is a global phenomenon that we're seeing at the moment. So there's a question here about whether there've been policies in other countries that have been effective in improving dynamism overseas.

I would struggle to point to a particular innovation. And again, we seem to be always saying: ‘Here's an issue; what can the government do about it, and what policies can happen?’ A lot of the theme here is about, this is about decisions that businesses make regardless of the landscape and how they view the opportunities that they face, rather than seeing everything in terms of constraint. This is the mindset issue that I talked about in my speech.

This issue of dynamism has really only been a relatively recently observed phenomenon in the literature. Unpicking what's going on has relied on new datasets that have only become available recently. There's been some really good work coming out of the OECD and out of the Australian Treasury on some of this. So I think people are still grappling with what to do about it.

Some of that work's been quite positive. Dan Andrews and the Treasury Centre work you spoke about has shown that high productivity firms were more resilient and more likely to expand during the pandemic. So that's a positive news story for Australia. That's good to see.

We've got a question here about confidence in business investment in Australia. So Lisa Liang has asked … she's noted that the foreign superannuation funds from the US and Canada have been entering the Australian market, particularly M&A in agriculture, and whether that's a sign that post COVID-19 confidence in businesses in Australia has returned. What are your thoughts on that?

It's the role of these large fund managers, whether pension funds or any other large fund manager, to diversify their assets. So, of course, those investors will be looking for opportunities in Australia, as well as elsewhere. I mean, we are a country that offers a great deal of opportunity. We have a highly-educated workforce. We have resources. We have good infrastructure. We have a really good legal framework. It's a very attractive place to invest relative to some other alternatives. So it doesn't surprise me that foreign investors would see this, and it wouldn't surprise me if Australian investors are seeing this.

So whether that's a particular post-pandemic thing or whether it is just simply what has already gone on before in terms of global funds managers looking for opportunities globally, it would be hard for me to say.

Yeah. And some of those factors that you mentioned just there are perhaps some of the strengths that might help Australia when it comes to dynamism and innovation. Things like a natural resource endowment, educated population come to mind, but there are some weaknesses as well in terms of perhaps people point to things like geographical isolation and a relatively small domestic market. What do you think are some of the strengths and weaknesses for Australian businesses when it comes to innovation?

Well again, I do think we have a highly-educated population. We have a good institutional framework. Absolutely we are more distant from the rest of the world, but we're now in a world where so many of the products and services that we are consuming are not really dependent on distance. I mean, I'm always amazed to find which of the software apps on my various devices are from quite small countries in Europe, for example, and the amount of independent development that we see, and that we are seeing in Australia as well. So I think increasingly, we will start seeing people realise that the tyranny of distance isn't quite such a tyranny anymore.

Indeed. Another theme that's come through this discussion has been the role of government or perhaps too much expectation placed on the role of government. There's a question here that says, well, if government doesn't have as much of a role to play, how do you change the mindset of businesses around investment decisions?

I wish I knew the answer to that question, but I've given it a red hot go today.

It's a million-dollar question, isn't it?

More than a million dollars.

Now, we're not focusing on interest rates and the path of interest rates today. The Governor did speak about that on Tuesday, but we have had a few questions coming through on that, so I'll give you an opportunity if you want to take that or pass on that question.

Well, I would refer back to what the Governor said on Tuesday. We also published the minutes on Tuesday. Nothing has changed in the last two days to make me want to change that message.

Absolutely. I might just finish off with one last question and this idea about laggards versus leaders, which you touched on. We know we have some firms operating at the frontier and others that are lagging behind and that the productivity gap between the two has widened. Do you think we're better off focusing our efforts on helping more laggard businesses to get closer to that productivity frontier? Or should we be taking a similar approach to New Zealand and focusing on capabilities that will push the Australian frontier out further, focusing on those frontier firms in the hope that a rising tide lifts all boats?

I think the important issue is that today's frontier firm may not remain the frontier firm of tomorrow. That's actually one of the findings from the OECD literature: that the firm that is the frontier or the superstar isn't necessarily going to remain the superstar forever. So focusing on more general capabilities and seeing where the cards fall, I think, is likely to be quite fruitful in this particular regard.

Well at CEDA we're very hot on capabilities, so that's a nice note to finish up on. Thank you so much, Luci. We're out of time, so we'll leave it there for today. On behalf of everybody on the call, I'd like to thank our guest speaker today, Dr Luci Ellis, for generously sharing her time and insights on this important topic. Thank you also to everyone for participating in the discussion today. There's been some really great questions come through.